1st May 2012
Early today there was something of a surprise event which touches on several of the themes established in this blog. And by the timing you have probably already guessed it was on the other side of the word or to quote Men at Work "Down Under". The Governor of the Reserve Bank of Australia announced this.
"At its meeting today, the Board decided to lower the cash rate by 50 basis points to 3.75 per cent, effective 2 May 2012. This decision is based on information received over the past few months that suggests that economic conditions have been somewhat weaker than expected, while inflation has moderated."
So Australia which has managed to escape many of the problems of the credit crunch era is finding itself being sucked into it. However some elements of the statement are not what you would expect and let me illustrate this.
"some forecasters have recently revised upwards their global growth outlook.
Financial market sentiment has generally improved this year, and capital markets are supplying funding to corporations and well-rated banks.
growth in domestic demand ran at its fastest pace for four years."
So there you have it the RBA has cut interest-rates following domestic demand being its best for four years! As a cut in interest-rates is in textbook terms usually considered to have the most effect on domestic demand we have something of an oddity here. Indeed the statements above are usually associated with interest-rate rises rather than cuts.This was counterbalanced to some extent by this in the statement.
"output growth was somewhat below trend over the past year"
So was it?
From the Australian Bureau of Statistics
"In seasonally adjusted terms, GDP and Non-farm GDP both increased by 0.4% in the December quarter"
And if we look to the breakdown of the numbers we see this.
"the main contributors to expenditure on GDP were Household final consumption expenditure (0.3 percentage points), Inventories (0.3 percentage points) and Net exports (0.3 percentage points) with Private gross fixed capital formation detracting 0.4 percentage points."
So we have both steady growth and growth in both consumption and net exports. Many countries in Europe would regard this as a Holy Grail right now rather than disappointing. the only issue was a fall in investment. Over the past year Australia's economic output as measured by growth in Gross Domestic Product has risen by 2.3% in seasonally adjusted terms and 2.8% without.
We do perhaps get some supporting evidence for this rate cut if we look at what happened to GDP growth in the previous two quarters as well. It has now gone in seasonally adjusted terms 1.4%,0.8%,0.4% so the trend looks downwards.
If we look backwards to see if the Australian economy has recovered any losses over the credit crunch era we can see that it has and in fact it has seen expansion. At the end of 2007 Australia's underlying GDP index was 92 and at the end of 2011 it was 107.8.
The strength of the Aussie Dollar has been a problem
We can look at this another way by seeing the impact of changes in the terms of trade for Australia. This is a measure where rises are bad-you are less competitive- and falls are good. Australia's terms of trade were rather conveniently 100 in March 2009 and then dropped to 92.7 in September 2009 before embarking on a rise which took it to 125.5 in December 2011. Ouch!
However as we look at wider impacts and secondary effects we see that this rise will also have helped shield Australia from the rises in oil and commodity prices which have taken place. So over time there will be a disinflationary effect. And we did get a sign of this in the latest national accounts.
"The GDP chain price index decreased 0.9% in the December quarter."
As you can see another quarter or two like that would change the picture substantially. And there are signs of the impact feeding directly into Australia's consumer price index as shown below.
Oh how the Bank of England would love those numbers! (For Monetary Policy Committee members reading this we are seeing the impact of an exchange rate on inflation, the same impact you call a "surprise").
Let me give you my overriding thought on this which is that the RBA looks to have failed in applying rule one of monetary policy in the credit crunch era. This is that when you do something is as important as how much. Today's rate cut was not a surprise it was the size of the move that was and it leaves the RBA looking like a body which is trying to play catch-up with events. It should have acted more decisively earlier.
Whilst the current outlook looks grim particularly in Europe it usually takes monetary policy 12-18 months to have a real impact. So what if the outlook is better then and the RBA finds its move impacting as the economy is recovering? It would be far from the first central bank which has found that delaying action has meant that its moves have reinforced swings in the economy rather than acting against them. Of course the future that far ahead is uncertain and the RBA may yet be lucky. But we are left with the question why now?
A Candidate: The Aussie Housing Market
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